Download Issue Focus - Prudential Capital Group

Special
Issue Focus
April 2017
TRUMP VERSUS REAGAN – GROWTH AND MARKETS
Did Reagan boost growth, and
how?
Since last November, many have sought to
compare the economic platform, and effects,
of the new Trump administration in the
U.S. with that of President Reagan in the
1980s. Optimistic observers, and to some
extent markets, have latched on to the
possibility that the Trump administration
could boost world growth through a mixture
of fiscal stimulus and deregulation. In
addition, the Trump policy mix is seen as
potentially positive for the dollar, stock
markets and commodity prices.
U.S. economic policy in the 1980s is often
remembered as featuring a strong ‘supplyside’ element: tax cuts, deregulation,
smaller government and freer trade.
The reality is more nuanced. The Reagan
administration was more ‘Keynesian’ than
many acknowledge, with much of the boost
to U.S. and world growth in the 1980s
coming from demand-side stimulus.
Indeed, U.S. growth in the 1980s benefitted
from a number of tailwinds that are wholly
or partially lacking now.
Chart 1: U.S. Fiscal Spending
% Year
18
15
Government Investment (LHS)
Fiscal Impulse (RHS)*
Reagan
Period
% of GDP
6
Forecast
12
5
4
9
3
6
2
3
1
0
0
-3
-1
-6
-2
-9
-3
1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018
Source: Oxford Economics, Haver Analytics and CBO
* Change in structural budget deficit
Chart 2: U.S. as World Trade Motor
% of GDP
4
2
U.S. Current Account Balance (LHS)
%
U.S. Share in World Trade Growth, 8-Year Rolling Period (RHS)
Reagan
Period
30
25
0
20
-2
15
• Excess capacity and high unemployment
after the 1980-82 recession. Today, we
-4
10
are eight years into an economic upturn
with spare capacity much more limited.
-6
5
• A steep decline in interest rates from late
1982 from very high initial levels. Today,
-8
0
1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
rates are low but on an upward trajectory.
Source: Oxford Economics, Haver Analytics and WTO
• Modest initial private sector leverage.
Today, leverage is down from pre-crisis
highs but still quite high.
• Sharp drop in world oil prices 1983-86.
Oil prices have been rising over recent
months.
• Large fiscal expansion. The U.S.
structural budget deficit rose from 1.8
per cent of GDP in 1981 to 4.5 per cent of
GDP in 1986, a large and sustained
stimulus. Government investment rose at
a double-digit pace in 1984-85 (see
Chart 1).
The Trump administration is also planning
a large fiscal stimulus; our forecast is for the
U.S. structural deficit to rise by around 2.0
per cent of GDP to 5.9 per cent of GDP by
2018. However, even assuming this stimulus
does occur, it will be taking place against a
much less supportive economic background
than Reagan’s did.
In addition to running quite large fiscal
deficits, the Reagan administration also
supported world growth by allowing the
U.S. current account deficit to expand, from
near balance in 1980 to more than 3.0 per
cent of GDP by the mid-1980s. The U.S.
accounted for around a quarter of world
trade growth in the eight years to 1987 (see
Chart 2).
So, the growth boost of the Reagan period
relied greatly on the widening of the U.S.’s
‘twin deficits’. It is open to price for stronger
growth. The Trump administration may
face resistance to expansionary fiscal policy
in Congress, and to date has expressed a
notable lack of tolerance concerning U.S.
external deficits.
Economic re-run of the 80s
unlikely
What about the prospects for boosting
growth through deregulation and other
‘supply-side’ reforms? The Reagan period
did see productivity growth in the U.S.
improve compared to the 1970s (see Chart
3). However, the improvement was partly
cyclical and was also visible in other
advanced economies.
A key area of 1980s reforms was cutting
marginal tax rates, but the impact was less
dramatic than it appeared (many households
did not see falling marginal rates).
Meanwhile, Reagan’s record on trade was
very mixed. The 1980s saw tariffs falling but
non-tariff barriers increasing, including
restrictions on Japanese cars and electronics
as well as steel imports from various
partners.
Overall, the Fraser Institute measure of
economic freedom suggests the U.S. became
‘freer’ in the 1980s, but from an already
fairly strong position, and by less than
economies like the UK and New Zealand.
There are reasons for believing that the U.S.
could benefit now from a dose of supply-side
reform; productivity growth is slow and
signs of flagging dynamism (e.g. falling
entry and exit rates of firms) have been
visible for some time.
However, the Reagan period warns us to be
cautious about how much to expect.
Moreover, it is not clear that the policies so
far put forward by Trump are well-suited to
reversing the U.S.’s loss of dynamism. The
emphasis on financial sector deregulation,
in particular, looks misplaced with little
evidence that the Dodd-Frank Act (despite
its flaws) has damaged credit supply.
Protectionist actions are also unlikely to be
conducive to faster productivity growth.
‘Trumponomics’ and asset prices
What about asset prices? Superficial
similarities exist between the initial impact
on asset prices of Trump’s election and
Reagan’s, notably rising stocks (especially
financials), a stronger dollar and a rise in oil
prices.
However, we doubt that asset price
performance over the next few years will
mirror that of the 1980s, particularly the
spectacular gains recorded by stocks and the
dollar. The real exchange rate of the dollar
soared by around 40.0 per cent by mid-1985,
while the S&P 500 doubled by 1987.
The prospects for dollar gains on a similar
scale to the 1980s look thin. The dollar was
weak in 1980 but has seen strong gains since
2014, and may be moderately overvalued.
Moreover, though the dollar should in
theory gain from rising U.S. yields, quite a
lot is arguably already priced into markets in
terms of expected Fed rate hikes. We expect
dollar gains from here to be modest.
The same argument can be used for stock
markets. Stock valuations were low in 1980,
and worsened in 1981-82 amid high yields
and recession. Stocks today, if anything,
look expensive based on long-term
valuations.
Chart 3: GDP and Total Factor Productivity (TFP)
% Year
10
U.S. GDP
World TFP Trend (7-Yr Average)
U.S. TFP Trend (7-Yr Average)
Reagan
Period
8
6
4
2
0
-2
-4
1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014
Source: Oxford Economics and Haver Analytics
Chart 4: U.S. Dollar and Stock Variations
Index
160
Dollar Real Effective Rate (REER) (LHS)
Shiller CAPE* (RHS)
P/E Ratio
50
Reagan
Period
150
45
40
140
35
130
30
120
25
20
110
15
Dollar
REER
Trend
100
90
10
5
80
1970
0
1976
1982
1988
1994
2000
2006
2012
Source: Oxford Economics and Haver Analytics
* cyclically adjusted p/e ratio
Moreover, collapsing interest rates from
1983 onward helped stocks, but equity
markets now face rising yields. As we are
also cautious that a supply-side revolution
will transform the outlook, a 1980s-style
stock surge looks unlikely. To us, the more
pertinent question is whether the rally since
November is sustainable.
One area where the Trump administration
may be more positive than Reagan’s is
commodity prices. A surging dollar and
initially high interest rates contributed to a
big decline in global commodity prices in
the 1980s. With these factors missing and
moderately higher U.S. growth adding to
demand, commodity prices may register
further modest gains. This will be good
news for emerging markets, which by
contrast had a rough time in the 1980s with
slow growth and a slew of debt defaults.
Conclusion
There are some similarities between the
Trump and Reagan eras but also many
differences. Reaganomics relied more on
demand-side measures and less on supply-
side measures than is often remembered,
and U.S. growth in the 1980s benefitted
from a number of tailwinds that are missing
today.
As a result, Trump’s proposed fiscal
stimulus will occur against a much less
favourable backdrop. The likelihood of a
‘productivity miracle’ is also limited,
especially given the policy proposals seen so
far. For global growth, a key issue is whether
the Trump administration and the U.S.
Congress will be willing to see the U.S.
budget and current account deficits widen in
the way the Reagan administration did in
the 1980s. This looks doubtful.
On asset prices, a re-run of the dollar and
stock price booms of the 1980s looks
unlikely: both assets were undervalued at the
start of the 1980s but are not now. Emerging
market assets, however, could do better than
in the 1980s if the Trump stimulus leads to
modestly higher growth and commodity
prices, and protectionist actions are
limited.
This update was researched and written by Oxford Economics, 121 St. Aldates, Oxford, OX1 1HB, England, as of 14 April 2017.
pricoacapital.com